The Centers for Medicare and Medicaid Services (“CMS”) has released a proposed rule to implement the “Physician Payment Sunshine Act” (the “Sunshine Act”), enacted as part of the Patient Protection and Affordable Care Act of 2010 (the “ACA”). The Sunshine Act requires pharmaceutical, medical device, and medical supply manufacturers to report payments and other transfers of value to physicians and teaching hospitals for certain drugs, devices, biologicals, and medical supplies covered under Medicare, Medicaid, or the Children’s Health Insurance Program (“CHIP”). The Sunshine Act also requires applicable manufacturers and group purchasing organizations (“GPOs”) to report information regarding ownership or investment interests held by physicians or their immediate family members in those entities.

The goal of the Sunshine Act is to increase transparency into the financial and ownership relationships among manufacturers, physicians, teaching hospitals, and GPOs. Recognizing that these relationships are often beneficial and necessary, the Sunshine Act does not prohibit any payments or ownership structures (however, state gift ban laws and federal laws addressing financial relationships with physicians remain); instead, the Sunshine Act solely requires public disclosure of the interactions in order to better understand those interactions and to dissuade the creation of inappropriate conflicts of interest that could negatively affect clinical integrity and patient care, and increase health care costs.

This article summarizes the key elements of the proposed rule, addresses ambiguities in the proposed rule, and points out some Sunshine Act reporting compliance issues that manufacturers should prepare for as the payment tracking date nears.

II. Start Date for Payment Tracking

The ACA requires manufacturers to begin tracking payments to physicians and teaching hospitals beginning January 1, 2012. However, CMS acknowledges that, due to the timing of the proposed rule, manufacturers will be unable to begin tracking payments as the statute indicates. CMS is considering requiring manufacturers to begin tracking payments 90 days following the agency’s publication of a final rule to implement the Sunshine Act. Depending on the publication date of the final rule, this could require manufacturers to begin collecting data for part of 2012. Although the start date is not immediate, manufacturers should begin to develop reporting processes to comply with the Sunshine Act so they are ready to track payments beginning sometime in the latter part of 2012.

III. Which Manufacturers Are Regulated?

The fundamental question in determining whether the proposed rule would require an entity to report payments to physicians and teaching hospitals, or report the ownership or investment interests held by physicians in the entity, is whether that entity meets the proposed definition of an “applicable manufacturer.” An “applicable manufacturer” is: (1) an entity “engaged in the production, preparation, propagation, compounding, or conversion of a covered drug, device, biological, or medical supply for sale or distribution in the United States, or in a territory, possession, or commonwealth of the United States”; or (2) any entity under common ownership or control of such an entity that “provides assistance or support to such entity with respect to the production, preparation, propagation, compounding, conversion, marketing, promotion, sale, or distribution of a covered drug, device, biological, or medical supply for sale or distribution in the United States, or in a territory, possession, or commonwealth of the United States.”

A key part of this definition hinges on whether the product that a manufacturer produces, prepares, propagates, compounds, or converts is a “covered drug, device, biological, or medical supply.”

a. What is a Covered Drug, Device, Biological, or Medical Supply?

A drug, device, biological, or medical supply is “covered” if payment is available for it under Medicare, Medicaid, or CHIP, either as a separately reimbursable item under a fee schedule payment or as part of a composite payment system, such as the Medicare inpatient or outpatient hospital payment systems.

In addition, only drugs that require a prescription can be “covered.” No over-the-counter products are “covered” under the proposed rule. Also, only medical devices and medical supplies that require either premarket approval by, or premarket notification to, the Food and Drug Administration can be “covered.” Consequently, Class I medical devices and supplies and those Class II devices and supplies that are exempt from 510(k) notification are not “covered.”

Whether payment is available for a drug, device, biological, or medical supply under Medicare, Medicaid, or CHIP is not always clear. For example, some medical devices, such as diagnostic testing machines, do not have CPT or HCPCS codes associated with the devices themselves. Services performed using those machines may be reimbursed, but the machines themselves cannot be reimbursed. Payment for those devices and supplies would never be available for reimbursement because those devices are not represented by a billable code, nor do they fall within a covered benefit category—they would not be reimbursed under Medicare, Medicaid, or CHIP regardless of the payment methodology.

CMS fails to clarify whether the definition of a “covered” medical device or medical supply includes only those devices and supplies for which separate CPT or HCPCS codes are available and either are or could be reimbursed separately under Medicare, Medicaid, or CHIP, or whether the definition encompasses any supply or device used in connection with any Medicare, Medicaid, or CHIP beneficiary for which services are reimbursed. This is an important question for a large segment of the medical device and supply industry.

b. Common Ownership and Control Entities

If an entity produces a covered drug, device, biological, or medical supply, it is an applicable manufacturer. Any entity under common ownership or control with that applicable manufacturer and that assists or supports the applicable manufacturer in producing, preparing, propagating, compounding, converting, marketing, promoting, selling, or distributing a covered drug, device, biological, or medical supply for sale or distribution in the United States is also an applicable manufacturer. This means that any payments either entity makes to any physician or teaching hospital must be reported.

c. The “One Covered Product” Rule

It is also noteworthy that CMS proposes that if an applicable manufacturer produces a single covered product, then the manufacturer must report all payments or transfers of value to physicians or teaching hospitals, including payments that have nothing to do with the covered product.

Broadening the definition of “applicable manufacturer” in this manner and applying the reporting obligation to all payments and transfers of value from applicable manufacturers may have unintended but significant impacts. For example, an integrated hospital system may manufacture custom orthotics or other devices for its patients that require a 510(k) notification and that may be reimbursed under Medicare or Medicaid (and are therefore “covered” medical devices or supplies). This applicable manufacturer could operate as a division within the same corporate entity that operates numerous hospitals and clinics. Alternatively, the corporate entity that operates hospitals and clinics may provide some support activities for the manufacturing operations. Under the proposed rule, these situations could result in an obligation to report all payments from the hospitals and clinics to any physicians, including employment compensation to employed physicians, fees to medical directors, and space and equipment lease payments. Those payments would have nothing to do with the manufacturing activity, but could be swept within the reporting obligation because of the broad proposed definition of “applicable manufacturer” and the proposed rule that payments unrelated to the covered product must be reported.

IV. Reports

There are two separate reporting obligations under the Sunshine Act. First, applicable manufacturers must report payments or other transfers of value to physicians and teaching hospitals. Second, manufacturers and GPOs must report information regarding the ownership or investment interests held by physicians or their immediate family members in such entities. These obligations are discussed below followed by an explanation of the report submission guidelines.

a. Reporting Payments or Other Transfers of Value to Covered Recipients

The proposed rule would require that any payment or transfer of value from an applicable manufacturer (or a third party on behalf of an applicable manufacturer) to a physician or teaching hospital (called “Covered Recipients”) must be reported annually to CMS. There are several categories of information that must be reported for each payment or transfer of value, including: Covered Recipient’s name; Covered Recipient’s business address; specialty and National Provider Identifier (“NPI”) for physician Covered Recipients; date of payment; name of the covered product if the payment or transfer is related to a particular covered product (the entity can report only one covered product per payment); form of payment; and nature of payment. CMS recommends using the National Plan & Provider Enumeration System because it includes a database of NPIs and is updated frequently, but seeks comment on whether there are other unique identifiers that could be used to identify physician Covered Recipients who do not have NPIs. CMS plans to publish a list of hospital Covered Recipients annually, including the name and address of each teaching hospital.

The Sunshine Act and the CMS proposed rule provide some detail about how manufacturers should describe payments in the report (e.g., cash or its equivalent, in-kind items or services, stock or any ownership interest, etc.) as well as the nature of payments (e.g., consulting fees, food and beverage, travel, research, charitable contribution, etc.). CMS’ proposed rule goes further by providing more detail about what qualifies as a charitable contribution, food and beverage payment, research payment, and direct compensation for serving as faculty or speaking for a medical education program. Certain payments and transfers of value are expressly excluded and need not be reported (e.g., transfers of value less than $10, product samples, educational materials, indirect payments to a Covered Recipient through a third party when the manufacturer is unaware of the identity of the Covered Recipient, etc.).

Although payments and transfers of value by the applicable manufacturer may be straightforward, CMS provides no explanation of what third party payments would be considered made “on behalf of” an applicable manufacturer. This is a significant issue for many manufacturers due to the wide range of third party distribution arrangements. For example, a manufacturer of drugs and medical devices may enter into a distribution arrangement with a third party distributor under which the distributor purchases the product and is responsible for marketing and selling the product to hospitals, clinics, or other parties. The manufacturer often does not know or receive reports of, nor does it control in any way, the distributor’s sales and marketing payments or any other aspects of the distributor’s sales and marketing functions. CMS does not indicate if or when a third party distributor’s payments to a physician might be considered made “on behalf of” the applicable manufacturer.

b. Reporting Physician Ownership and Investment Interests

For reporting ownership and investment interests by physicians or their family members in applicable manufacturers or GPOs, the Sunshine Act uses the term “Physician” instead of Covered Recipient. The definition of “Physician” is borrowed from Section 1861(r) of the Social Security Act and includes all physicians, regardless of whether a physician is an employee of the applicable manufacturer, and includes the ownership and investment interests of the physician’s immediate family members. This is broader than the definition of Covered Recipient used for reporting payments and transfers of value.

Less information is required to satisfy the ownership and investment reporting obligation than the payment and transfer of value reporting obligation. The applicable manufacturer or GPO must report the name, address, NPI, and specialty of the physician owner or investor, and whether such interest is held by a family member of the physician. CMS is considering requiring the report to state the immediate family member’s name and relationship to the physician. This would bring more transparency, but may raise privacy issues.

The CMS proposed rule states that if an entity is required to report payments or transfers of value and ownership or investment interests, and such reports would be duplicative, the entity can report under the payment and transfer of value provision and need not also report under the ownership and investment interest provision.

c. Report Submission

The proposed rule requires the report to be submitted electronically in a comma-seprated value format to CMS on March 31, 2013 and on the 90th day of each calendar year following 2013. Reporting entities, however, can submit their data prior to the designated date. CMS proposes a requirement that applicable manufacturers who have information to disclose must register with CMS prior to reporting. Such registration would begin January 1, 2013. CMS, however, is considering whether to require all applicable manufacturers and GPOs to register regardless of whether they have information to report. If required to register, entities with nothing to report would file an attestation that there were no reportable payments or transfers of value and/or ownership or investment interests during the previous calendar year.

V. Penalties

An applicable manufacturer or GPO that fails to timely file the required report will be subject to a civil monetary penalty of at least $1,000, but no more than $10,000, for each payment or other transfer of value or ownership or investment interest not reported. There is, however, a maximum penalty of $150,000 per annual submission failure. For a knowing failure to timely file, the applicable manufacturer or GPO will be subject to a penalty of at least $10,000, but no more than $100,000, for each payment or other transfer of value or ownership or investment interest not reported. The maximum penalty per knowing annual submission failure is $1,000,000. “Knowing” in this context means that an individual has actual knowledge of the information, acts in deliberate ignorance of the truth of falsity of the information, or acts in reckless disregard of the truth or falsity of the information.

CMS proposes that the penalty amount be assessed based on the length of time the entity fails to report, the amount of the payment or transfer of value that was not reported, the level of culpability, the nature and amount of information reported in error, and the degree of diligence exercised in correcting information reported in error.

VI. What State Laws Are Preempted?

The Sunshine Act itself specifies that the applicable provisions preempt any State or local laws requiring reporting, in any format, of the same “type of information” reported under the provision. No State or local government may require separate reporting unless the information is collected by a Federal, State, or local government agency for public health surveillance, investigation, or other public health purpose.

Another question the proposed rule does not answer relates to the scope of the federal law’s preemption. Will the federal regulation preempt state laws that require reporting of payments by manufacturers to physicians and teaching hospitals even if those state laws request reporting of different data elements than the federal regulation requires? Or does the federal regulation preempt only those state laws that require reporting of the exact same data elements? Unless the preemption provision is interpreted broadly, manufacturers could find themselves required to submit annual reports to CMS and small reports to state agencies regarding data elements that are not specifically requested under the federal rule.